Markets have flipped from pricing near-certain Fed rate cuts to pricing zero cuts and a greater than 50% chance of hikes by year-end
The upcoming June FOMC meeting should include a healthy debate on the current inflation trend, including the potential secondary effects of the oil spike and tariffs
Beyond near-term rate moves, the bigger question is Warsh’s appetite for structural reform—which requires building consensus across the FOMC, markets, and Congress.
The Iran conflict has reshaped the narrative in interest rate markets. Since February 27, just before the US and Israel launched joint strikes, front-end Treasury yields have climbed more than 60 basis points. Back in February, worries over private credit and AI disruption dominated, fueling speculation of broader contagion to the US economy. But March’s surge in oil prices triggered a global bond sell-off. The move in Treasury yields tracked a sharp repricing of Fed expectations: in late February, markets priced a 96% probability of cuts by the end of 2026, including a 78% chance of two or more cuts. By June 1, that had flipped to a 0% probability of any cut this year and a greater than 50% chance of one or more hikes (Exhibit 1).
Exhibit 1
Source: BMO, ALM First
This ultimately comes back to an inflation conversation. The oil spike could prove a temporary supply shock with no lasting impact on growth or inflation trends—provided the conflict resolves quickly and prices fall. The longer energy prices stay elevated, the more likely the effects spread beyond the pump. April’s PPI, for instance, showed an 8.1% jump in trucking freight rates. If that persists, firms will likely raise goods prices to protect margins.
The hawks have ready counterarguments. Higher oil prices aren’t yet captured in a trimmed measure, but they can eventually bleed into the middle 45% of components—as can the secondary effects of steel and aluminum tariffs across manufacturing. Another factor likely still fresh in hawkish memory: the trimmed-mean index lagged core PCE by nearly 2 percentage points in late 2021, just before the Fed had to drop the hammer with 525 bps of hikes. An end to the conflict, including a reopening of the Strait of Hormuz, should bring sharp relief in oil prices and ease some—but not all—of these worries. Several Fed officials flagged lingering inflation concerns even before the first missile flew. There’s also the risk of repeated “one-off” shocks becoming entrenched in expectations, a far thornier problem for policymakers.
How Will Warsh Tackle Reforms?
While markets fixate near-term on hikes and cuts, the bigger question for us is how Warsh will approach larger reforms to monetary policy and communication. He has been publicly critical in several areas: quantitative easing and the Fed balance sheet; forward guidance, including the “dot plot,” press conferences, meeting minutes, and the 2020 framework shift to flexible average inflation targeting.
His sharpest criticism targets QE, which he argues has mainly benefited financial markets and asset owners while widening wealth inequality; he prefers less Fed involvement in markets overall. This is by far the toughest reform given the balance sheet’s $6.7 trillion size, down from its $8.9 trillion peak in early 2022, but shrinking it too fast risks a major liquidity disruption in short-term funding markets.
Forward guidance may be easier to change, but not unilaterally. Warsh will need to build FOMC consensus to alter the Summary of Economic Projections, statement language, and the timing of minutes. He has the most control over the frequency and tone of his own press conferences, though the Chair ultimately answers to Congress on transparency. Several of his criticisms have merit—but now comes the hard part. He must sell these reforms to multiple constituencies, starting with the FOMC.
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